In a significant judgment, the Supreme Court has clarified that banks must adhere to the procedures outlined in the Centre’s 2015 guidelines before classifying Micro, Small, and Medium Enterprises (MSMEs) loan accounts as Non-Performing Assets (NPAs).
The ruling emphasizes that banks cannot label MSME loans as NPAs without following the mandatory steps outlined in the Framework for Revival and Rehabilitation of MSMEs. This framework, established by the Ministry of MSME on May 29, 2015, is designed to provide a structured approach for addressing financial stress among MSMEs and promoting their recovery and development.
According to the Court, banks must first identify any early signs of stress in MSME accounts by categorizing them into three sub-categories under the “Special Mention Account” category. The Reserve Bank of India (RBI) reinforced this requirement in its Master Circular issued on July 21, 2016, making these instructions legally binding for all scheduled commercial banks in India.
The Court’s decision highlights that the procedures outlined in the 2015 notification and the subsequent RBI directives are mandatory. Banks and Non-Banking Financial Companies (NBFCs) must follow these procedures before taking any actions that could lead to the classification of an MSME loan as an NPA.
In this case, the banks and NBFCs had initiated recovery actions under the SARFAESI Act without complying with the MSME Ministry’s guidelines. The Court ruled that without proper identification of incipient stress and adherence to the specified procedures, it is impermissible for these institutions to classify MSME loans as NPAs.
Additionally, the Court noted that MSMEs are required to provide verifiable proof of their status to benefit from the framework. Failure to do so could result in banks seeking enforcement of security interests under the SARFAESI Act. The Court stressed that MSMEs must be proactive in demonstrating their eligibility for the framework’s benefits to avoid adverse consequences.
On a related note, the Court overturned a High Court decision which had ruled that banks are not obligated to initiate restructuring processes independently. The Supreme Court found this view to be erroneous, reaffirming that banks must follow the 2015 guidelines regardless of whether an application for restructuring is made by the MSMEs.
In summary, the Supreme Court has reinforced the importance of following procedural requirements before classifying MSME loans as NPAs, thereby providing a more structured and supportive approach to managing financial stress in the MSME sector.
